11 insider plays that can bring you added income

MarketWatch asked money managers where they hunt for extra yield

By

LauraMandaro

Slide 1 of 12

Health-care muni bonds.

President Obama’s 2010 health-care overhaul cast a pall of uncertainty over hospitals. Among the biggest fears: the hit from looming cuts to Medicare and Medicaid reimbursement rates as the government moves to squeeze costs out of the system. For John Loffredo, co-manager of the $970 million MainStay Tax Free Bond Fund
MTBAX, +0.00%
that’s meant a buying opportunity. As details of the law become more clear, he says lower rates are coming to seem less severe than initially feared. At the same time, hospitals stand to benefit from the law’s insurance mandate by having to treat fewer people without any insurance at all. “Few patients will fall through the cracks,” he says. While health-care bonds are considered riskier than those issued by, say U.S. states or big cities, consolidation in the industry is steadily improving many operators’ balance sheets. Although spreads have narrowed in the past year, health-care bonds’ 3.41% average yield is still about 0.17 percentage point higher than other munis.

Oil, industrial stocks that pay solid dividends

Strong demand for defensive stocks—the consumer staples, cyclical and telecommunication shares that typically pay high dividends—have made these income favorites fairly pricey. Estimated price-to-earnings ratios for 2013 average 17 times for defensive sectors compared to 13.5 times with cyclicals, or sectors including energy, natural resources and financials. That makes it even more imperative for investors to be “a bit more selective,” Sam Stovall, chief equity strategist at S&P Capital IQ, said in a recent note. Stovall’s picks all pay dividend yields of 3% or more and have a STARS rating of 4 or more. STARS is an S&P Capital IQ ranking system from 1 to 5, where 5 is equivalent to a “strong buy” while 4 is a “buy.” While many of these favored dividend plays draw from traditional defensive sectors, including tobacco company Altria Group Inc.
MO, -1.76%
and food company General Mills Inc.
GIS, +0.07%
others fall into the cyclicals camp, including Chevron Corp.
CVX, -0.86%
and General Electric Co.
GE, -1.39%

—Wallace Witkowski

Slide 3 of 12

The dollar as best of the bunch

Liquidity injections from central banks tend to drive investors to high-yielding and high-risk currencies. But the slowdown seen in the euro zone and China will lead to dollar strength, because “there’s no other place to put your money,” says Steven Englander, global head of G-10 strategy at Citi. “Atypically, we expect the dollar to do well because the growth disappointments will offset the liquidity impact that you’ve been seeing,” he said. He says to take a look at the U.S. equity market’s outperformance of the Chinese stock market, which is characterized by higher risk and higher growth. A normal hunt for yield would signal a willingness to go up the risk curve, and away from U.S. assets, but this typical situation doesn’t hold currently because of global growth concerns.

—Saumya Vaishampayan

Slide 4 of 12

Juice left in junk

High-yield bonds are a favorite debt investment for Ad van Tiggelen, investment strategist at ING Investment Management. He points to a chart that shows high-yield spreads versus Treasurys are still quite high in an historic context, especially considering high-yield default rates remain low. The so-called “carry,” or current yield assuming prices are static, remains attractive, he says, and “we do not expect default rates to become a problem in 2013 or 2014.”

“Where we still like below-investment-grade investments in fixed income, our preference elsewhere clearly lies with equities with a reasonable dividend yield (2% to 3%) which is sustainable and can rise further. In this sense, the pharma sector is by far our preferred investment category.”

—Barbara Kollmeyer

Slide 5 of 12

Emerging-market bonds

Emerging markets are no new entrant to the high-yield sector of the bond market, but credit quality makes them an increasingly safe investment, according to Jennifer Vail, head of fixed-income research at U.S. Bank Wealth Management. “Credit quality in emerging markets is on an incline whereas credit quality in emerged markets is on the decline,” she said. One such indicator of credit quality could be the ratio of public debt to gross domestic product, according to Joyce Chang, global head of fixed-income research at J.P. Morgan. Back-of-the-napkin calculations show public-debt-to-GDP is around 35% for developing nations, and closer to 100% for developed nations, she said at a talk last month. And the returns are nothing to shrug at: the Barclays Emerging Markets Local Currency Index returned 25.12% over the last 3 years and its counterpart, the Barclays Emerging Markets Hard Currency Index, returned 31.9% in that same time-frame.

—Ben Eisen

FactSet

Slide 6 of 12

A natural-gas rallying point

Natural-gas prices have come down significantly over the past few years, and the resulting increase in demand has been a boon to companies that deliver natural gas throughout the United States, according to Skip Aylesworth, portfolio manager of the Hennessy Gas Utility Index Fund
GASFX, -0.86%
at Hennessy Funds. In fact, an index containing publicly traded member companies of natural-gas distribution group American Gas Association has continually outperformed the S&P 500 Index. In the first quarter of 2013, the AGA Stock index had an annualized return of 14.41% compared to the S&P’s 10.61%. And with substantial natural-gas reserves available, this rally is likely to continue, said Aylesworth.

—Ben Eisen

Slide 7 of 12

Mortgage-backed securities

The $1 trillion residential-mortgage-backed-securities market provides relatively attractive yield in this low-interest-rate environment, according to Matt Bass, vice president for securitized management at AllianceBernstein. But since more than two-thirds of non-agency RMBS are floating rate, rising interest rates would support stronger performance.

“Mortgage-related securities have exhibited low historical correlation relative to other fixed-income and equity investments,” says Bass, making them one way to diversify a portfolio. As the fundamentals of the housing market improve, the rate of default for mortgage borrowers that ultimately back the securities is going down, as the chart at left shows.

—Ben Eisen

FactSet

Slide 8 of 12

Hidden growth trades

Drill down to find out what’s driving gains in dividend payers: That growth could be coming from non-defensive plays. Dan Greenhaus, chief global strategist at BTIG, doesn’t buy into thinking that sectors like consumer staples or utilities are rising just because investors are afraid to take risks on more growth-oriented stocks. “Defensives leading for defensive reasons is inaccurate,” Greenhaus said.

Take health care, which is the leading sector year-to-date. When people think of health care, Greenhaus said, they think of big names that do well no matter what, such as big pharma and managed-care companies. But one of the major drivers in the sector currently is biotech, not a particularly defensive play. Compare the performance of the Health Care Select Sector SPDR Fund
XLV, -1.25%
versus the iShares Nasdaq Biotechnology Index Fund
IBB, -1.70%
The XLV has grown 22%, while IBB has advanced 31%, year to date. Consumer staples, another defensive sector, is also leading the pack, but it’s not just about the attractive dividend yields, Greenhaus said. The sector is also filled with potential M&A targets like Beam Inc.
US:BEAM
and WhiteWave Foods Co.
US:WWAV
which are getting price support for non-defensive reasons.

—Wallace Witkowski

Slide 9 of 12

Real estate

She points to a chart showing the initial yield on a real-estate index called the Investment Property Databank, or the annualized rents (income) of the property expressed as a percentage of the value of the property. This yield has been well above benchmark British bond and stock yields for the last five years. “Real estate is in a part of the cycle where all the income is coming from the income side in terms of rental yields, which is an attractive yield compared to government bonds,” she said.

Additionally, if there’s inflation in the financial system, real-estate prices tend to rise with the broader economy, providing a sort of inflation protection, she said. Focus on the better properties, the so-called prime sector, and avoid segments under pressure, such as U.K. retail real estate. Hudson also says high-yield corporate bonds are attractive, as they offer higher yields than government bonds, are likely to be less indebted that governments and currently don’t suffer from high default risks.

—Sara Sjolin

FactSet

Slide 10 of 12

Paywall yield

Ken Crawford, a senior portfolio manager at St. Louis-based Argent Capital Management, highlights media company Gannett Co.
GCI, -1.09%
as an income-producing member of the firm’s Dividend Select portfolio. The stock has a 3.7% dividend yield and a 10.5% free cash flow yield, and it trades at 10 times forward earnings. As a catalyst for the stock, Crawford notes Gannett is implementing a pay wall for its online print content.

”Argent believes if GCI’s pay wall were to work and GCI were to stabilize its readership, there is considerable upside in the stock. In the meantime, shareholders are enjoying the yield GCI is delivering and the safety GCI’s cash flow affords. He points to a chart that shows how the stock has done relative to the Russell 1000
RUI, -1.54%
for the past year, the period Argent Capital has owned the stock. (The chart has both price points indexed to 100)

—Myra P. Saefong

Slide 11 of 12

Blue chips

Blue-chip companies that pay dividends are a safe bet for investors given the current investing climate, says Phil Orlando, equity market strategist at Federated Investors.

In sizing up three major asset groups, Orlando notes that cash is yielding nothing, a scenario in play for about five years. “And, on the basis of interest rates and inflation, and what the Federal Reserve has told us, that’s unlikely to change anytime soon. With core inflation at 1.3%, and unemployment where it is, it’s unlikely the funds rate is changing, so the practical implication is you are getting less than zero on cash, because there is some inflation out there.”

With the benchmark 10-year Treasury note
US:10_YEAR
yielding less than 2%, and the average yield on the S&P 500
SPX, -1.54%
at 2.13%, Orlando argues for yield-centric products, or dividend payers, such as the Federated Strategic Value Fund
SVAAX, -0.80%
which is made up of a bunch of blue-chip companies and offers a 5% gross yield.

—Kate Gibson

Slide 12 of 12

Blue chips

Blue-chip companies that pay dividends are a safe bet for investors given the current investing climate, says Phil Orlando, equity market strategist at Federated Investors.

In sizing up three major asset groups, Orlando notes that cash is yielding nothing, a scenario in play for about five years. “And, on the basis of interest rates and inflation, and what the Federal Reserve has told us, that’s unlikely to change anytime soon. With core inflation at 1.3%, and unemployment where it is, it’s unlikely the funds rate is changing, so the practical implication is you are getting less than zero on cash, because there is some inflation out there.”

With the benchmark 10-year Treasury note
US:10_YEAR
yielding less than 2%, and the average yield on the S&P 500
US:SPX
at 2.13%, Orlando argues for yield-centric products, or dividend payers, such as the Federated Strategic Value Fund
US:SVAAX
which is made up of a bunch of blue-chip companies and offers a 5% gross yield.

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